Name That Trade – $ANF’s Situation

by Dan March 3, 2015 2:59 pm • Commentary

Event: Abercrombie & Fitch (ANF) reports their Q4 tomorrow before the open. The options market is implying a 14% one day move, vs the 4 qtr avg of about 6.5%, with three of those moves higher by an avg of 7% and one move lower by about 5%.

Sentiment towards the shares could not be worse (we will know more tomorrow at 10am) with 29% short interest interest, and the Wall Street analyst community which has basically thrown in the towel with 10 Buy Ratings, 19 Holds and 6 Sell ratings. One such analyst who move to a Sell last week had the following reasons, per Bloomberg:

Wunderlich: Based on pricing surveys, store tours, worries over FX, tourist traffic, West Coast dock issues, it will be “nearly impossible” for ANF to achieve “even recently lowered guidance”

ANF continues to struggle with fashion issues, waning teen interest; combined with FX issues, what Wunderlich sees as “material slowdown” in European tourist traffic, sees “material step backwards” for ANF

I don’t know what a Wunderlich is, but the view sounds downright horrible.

Speaking of horrible, the long term chart of the stock is quite possibly one of the worst things I have ever seen.  The 10 year chart below shows the massive head and shoulders top with the stock having broken below the $30 neckline on massive volume back in November.

[caption id="attachment_51567" align="aligncenter" width="600"]ANF 10yr chart from Bloomberg ANF 10yr chart from Bloomberg[/caption]

On a near term basis the stock looks a tad oversold, down almost 50% from the 52 week highs made in late August:

[caption id="attachment_51568" align="aligncenter" width="600"]ANF 1yr chart from Bloomberg ANF 1yr chart from Bloomberg[/caption]

Recent activity in the options market has been decidedly bearish, last week Mike Khouw highlighted some short dated out of the money put buying (watch here). When the stock was 23.85 on Thursday a trader paid .20 for 15,000 of the March 13th weekly 18 puts, which break-even on next Friday’s close down 25% at $17.80, WOW!

On the flip side, yesterday saw heavy call volume, with calls outnumbering puts 3 to 1, with 9 of the top 10 strikes all calls.  The two most active strikes on the day were 8,000 of the March 24.5 calls, and 8,000 of the March 28 calls this looked like an opening buyer of the March 24.50/28 call spread at its highest level paying about 1.20 for the 3.50 wide spread.

Vol Snapshot: As you would expect, options prices have shot through the roof well above levels from the three prior earnings reports:

[caption id="attachment_51569" align="aligncenter" width="600"]ANF 1yr chart of 30 day at the money implied vol from Bloomberg ANF 1yr chart of 30 day at the money implied vol from Bloomberg[/caption]

MY VIEW:  For the first time in my life I went into an ANF store before Christmas to shop for my daughters. Frankly I was mortified by the experience. The stores are dark and have music blaring and reeked of perfume.  The staff were inattentive and the style looked bad. However! The sweater and jacket I bought for my 11 yr old daughter was the hit of the gifts that I gave her. But, everything in the store was massively discounted, and from my channel checks, they remain so!  That’s purely anecdotal, but to me it suggests that they still make stuff that kids want, so while they have no shortage of headwinds things can be turned around.

I would also add that despite the stock’s poor performance, the company’s mis-execution has caused earnings to be cut in half in the last two years while sales are down 16% in that time period. The balance sheet is far from impaired with $320 million in cash and $350 in debt with only a $1.67 billion market cap.  At some point soon, someone, or some entity must see some value here. The question is whether that time comes some 20% lower than current levels.

This is a clear example where expectations are very low and the fundamentals are very weak.  Buying way out of the money puts seems like a lottery ticket, playing for an out-sized move into an event where the market is already pricing fireworks.

No matter what your view, if you are looking to express a directional view, near term short premium strategies probably need to be a part of it.

Potential Trades:

A contrarian bullish view can be expressed with a call calendar near the expected move. The March 6th weekly/ May regular 27 call calendar is only .60. That trade could set up great from some sort of recovery in the shares over the next few months without risking too much on the event.

If sentiment is correct and this stock stays in the penalty box, for a bearish view, the March regular 25/21/17 put fly may be the way to play at around 1.10. This isn’t exactly short premium but it lays off a lot of the high volatility risk by having a breakeven quite near where the stock is currently trading (breakeven on this trade is 23.90 with the stock currently at 24.10). This structure is best viewed as a defined risk short isolating the expected move to the downside.